K-pop recovery becomes an h-flop

Techs drag down US stock markets

First of all, everybody calm down please. Last night’s histrionics on Wall Street were interesting for what did not happen as opposed to what did. Stock markets got a well overdue thumping with big tech leading the way South. The technical expression is a downward correction in overbought stocks after an intense period of one-way price action higher. For the rest of us, the market was long and wrong, and now some of their P&L is gone.

That much-vaunted inequality flag of everything that is wrong with Western Capitalism, the K-shaped recovery led by tech stocks, may, for a while, start to look like an h-shaped one. That will be no bad thing in the longer-term.

What is particularly interesting is not what did happen, but what didn’t happen. The US dollar finished the day almost unchanged, with the dollar index up only 0.14%. No signs of massive safe-haven flow there. Gold fell only 0.60%, when in stock selloffs of Christmas past gold would have been cremated as cash was raised to cover equity margin calls. US yields fell only slightly across the curve. If we were facing a massive risk-off event, yields would have plummeted as investors rotated into US government bonds. Even Brent crude and WTI only fell by around 40 cents a barrel.

So, the overnight sell-off appears to have been confined to the stock market. Looking at the insane level of short-term call open interest, and the lofty P/E valuations of the K-Pop recovery darlings of Wall Street, the rout overnight was due to happen sooner or later. It just happened to be last night. Can the FOMO-gnomes of Wall Street continue receiving hard love? Absolutely. As Mohamed El-Erian (one of my idols and he owns a golden retriever) postulated overnight, that stock markets could fall by another 10-15%. Given the scale of the rally since mid-March, that would still leave equity markets comfortably in a bull market scenario, but with saner valuations. A K-shaped recovery turning into an h-shaped one for a while would be no bad thing.

The underlying drivers of the buy everything rally remain firmly intact. The ocean of zero per cent central bank money looking for a home, distorting asset markets, just like after the GFC. Dollops of fiscal stimulus to come across the world. A global savings glut looking for yield anywhere—lower rates for longer everywhere except China, which is already recovering nicely anyway. According to economic textbooks, such conditions should be wildly inflationary; I haven’t seen any though, in the last 15 years. If any readers catch sight of it, please photograph it and send it in. I know many central banks who would love to have some. Sharing is caring.

The incompetence and dereliction of duty to their people by the elected officials on Capitol Hill, by failing to enact a follow-on fiscal stimulus package, is a risk point. The November US election, which I suspect will be much closer than the polls suggest, is another. The arrival of Covid-19 vaccines in Q4 should be another, thankfully a positive one for a change. But they are all risks, not certainties. In the future, they should introduce some welcome two-way price action to the K-shaped investment thesis. That will be healthier for equity markets in the longer-run then the buy-everything FOMO-tulip mania of the past six months.

There is always a but, though. That will arrive this evening in the shape of the US Non-Farm Payrolls. Ironically, last night US Initial Jobless Claims was the best in months, and yet here we are facing the smoking ruins of an aggressive overnight sell-off in US equities. The FOMO gnomes of Wall Street may be down and licking his/her wounds, but they are not out. A strong showing by the payrolls data could see the top of the stock market everyone will be hand wringing about today, reverse as soon as it started. The lack of fall-out in other asset classes further reinforces this possibility.

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